New Jersey enacts significant changes to S corporation election

In detail

Separate state S corporation election eliminated

Prior to the enactment of A4295, New Jersey required taxpayers to apply for S corporation status even if the taxpayer was treated as an S corporation for federal income tax purposes. Unlike most other states that automatically conform to federal S corporation treatment, New Jersey required a separate state election. If a taxpayer failed to make this state election, the entity would be required to file and pay tax as a C corporation on any income allocated to the state. 

Observation: The separate state election was a trap for the unwary, sometimes resulting in late filing penalties and interest on unpaid Corporation Business Tax. While New Jersey’s regulations provided for a retroactive S corporation election, some taxpayers faced challenges in having retroactive applications approved by the Division of Taxation.

A4295 eliminates the separate state election by amending the definition of a “New Jersey S corporation” to now mean “a taxpayer that has made a valid election to be taxed as an S corporation for federal tax purposes.” The legislation also provides for more liberal application of regulatory requirements governing retroactive S corporation treatment, in favor of the corporation requesting retroactive S corporation status. 

Additionally, the legislation provides for a new election that allows a taxpayer to ‘opt-out’ of S corporation treatment for state purposes if consent of 100% of the shareholders of the S corporation is provided. 

The changes to New Jersey’s S corporation election rules apply to privilege periods beginning after December 22, 2022.

Observation: Several details with respect to this change will need to be clarified. It is expected that the Division of Taxation will issue guidance soon. For example, it remains unclear what forms, if any, may need to be filed and when to be treated as an S corporation or opt-out of S corporation status for state purposes. Similarly, some entities that chose to have hybrid treatment (i.e., federal S corporation and New Jersey C corporation) will need guidance on how to maintain their hybrid status. 

Certain COVID-related extensions end

A4295 also ends the extension of time for the statute of limitations on tax due that was enacted in response to the COVID-19 pandemic. The legislation also ends the extension for the provisions regarding the State’s payment of interest on a taxpayer’s overpayment of tax, which were legislatively tied to Gov. Phil Murphy’s (D) declaration of the state of emergency on March 9, 2020. 

As explained in the bill Statement, on June 4, 2021, Gov. Murphy terminated the public health emergency with Executive Order No. 244, but did not terminate the state of emergency. The legislation changes the end dates for the extension of time for the statute of limitations on tax due and payment of interest on overpayments of tax, so they are tied to the effective date of A4295, which is December 22, 2022.